Can any of the company-specific risk be diversified away by investing in both Microsoft and Exxon at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining Microsoft and Exxon into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between Microsoft and Exxon Mobil Corp, you can compare the effects of market volatilities on Microsoft and Exxon and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in Microsoft with a short position of Exxon. Check out your portfolio center. Please also check ongoing floating volatility patterns of Microsoft and Exxon.
Diversification Opportunities for Microsoft and Exxon
The 3 months correlation between Microsoft and Exxon is -0.77. Overlapping area represents the amount of risk that can be diversified away by holding Microsoft and Exxon Mobil Corp in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on Exxon Mobil Corp and Microsoft is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on Microsoft are associated (or correlated) with Exxon. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of Exxon Mobil Corp has no effect on the direction of Microsoft i.e., Microsoft and Exxon go up and down completely randomly.
Given the investment horizon of 90 days Microsoft is expected to generate 3.13 times less return on investment than Exxon. In addition to that, Microsoft is 1.01 times more volatile than Exxon Mobil Corp. It trades about 0.02 of its total potential returns per unit of risk. Exxon Mobil Corp is currently generating about 0.07 per unit of volatility. If you would invest 5,915 in Exxon Mobil Corp on September 4, 2023 and sell it today you would earn a total of 4,384 from holding Exxon Mobil Corp or generate 74.12% return on investment over 90 days.
Compared to the overall equity markets, risk-adjusted returns on investments in Microsoft are ranked lower than 11 (%) of all global equities and portfolios over the last 90 days. In spite of comparatively uncertain technical and fundamental indicators, Microsoft may actually be approaching a critical reversion point that can send shares even higher in January 2024.
Over the last 90 days Exxon Mobil Corp has generated negative risk-adjusted returns adding no value to investors with long positions. In spite of latest unsteady performance, the Stock's basic indicators remain healthy and the recent disarray on Wall Street may also be a sign of long period gains for the firm insiders.
The main advantage of trading using opposite Microsoft and Exxon positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if Microsoft position performs unexpectedly, Exxon can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in Exxon will offset losses from the drop in Exxon's long position.
The idea behind Microsoft and Exxon Mobil Corp pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.
Check out your portfolio center.Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the ETF Categories module to list of ETF categories grouped based on various criteria, such as the investment strategy or type of investments.
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